Risk Finance and Asset Pricing : Value, Measurements, and Markets

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Charles Tapiero, as the head of the biggest financial engineering program in the world and business consultant, has his finger on the pulse of the shift that is coming in financial engineering applications and study. With an eye toward the future, he has crafted a comprehensive and practical book that emphasizes an intuitive approach to the financial and quantitative foundations of financial and risk engineering and its many applications to asset pricing and risk management. Covering the theory from a practitioner perspective, he then applies it to a variety of real world problems. The book presents important techniques to price, hedge, and manage risks in general while acknowledging the high degree of uncertainty in the real world.

Charles S. Tapiero is the Topfer Distinguished Professor of Financial Engineering and Technology Management at the New York University Polytechnic Institute. He is also Chair and founder of the Department of Finance and Risk Engineering, as well as cofounder and co-Editor in Chief of Risk and Decision Analysis. An active researcher and consultant, Professor Tapiero has published over 350 papers and thirteen books on a broad range of issues spanning risk analysis, actuarial and financial risk engineering, and management, including Risk and Financial Management: Mathematical and Computational Methods, also by Wiley.

Introduction

Who This Book is For

How This Book is Structured

What's on the Companion Website

Risk, Finance, Corporate Management and Society

Overview

Risks Everywhere-A Consequence of Uncertainty

Risks and Finance: Basic Concepts

Example: An IBM day-trades record

Example: Constructing a portfolio

Option Contracts

Options and their Price

Example: Options and the Price of Equity

Example: Management Stock Options

Options and Trading in Specialized Markets

Real Life Crises and Finance

The 2008 Meltdown and Financial Theory

Finance and Ethics

Summary

Test Yourself

References

Applied Finance

Overview

Finance and Practice

Financial Risk Pricing: A Historical Perspective

Essential of Financial Risk Management

Technology and Complexity

Market Making and Pricing Practice

Summary

Test Yourself

References

Risk Measurement and Volatility

Overview

Risk, Volatility and Measurement

Moments and Measures of Volatility

Example: IBM Returns Statistics

Example: Moments and the CAPM

Calculating the Beta of a Security

Statistical Estimations

Example: The AR(1) ARCH(1) Model

Example: A Garch (1,1) Model

High-Low Estimators of Volatility

Extreme Measures, Volume, and Intraday Prices

The Probability of the Range

Data Transformation

Example: Taylor Series

Value at Risk and Risk Exposure

Example: VaR and Shortfall

Example*: VaR, Normal ROR and Portfolio Design

Summary

Test Yourself

References

Risk Finance Modeling and Dependence

Overview

Introduction

Statistical Dependence

Example: Risk Factors Aggregation

Example: Principal Components Analysis (PCA)

Example: A Bi-Variate Data Matrix and PCA

Example: A Market Index and PCA

Dependence and Copulas

Example: The Gumbel Copula, the Highs and the Lows

Example: Copulas and Conditional Dependence

Example: Copula and the Conditional Distribution

Financial Modeling and Inter-Temporal Models

The R/S Index

Summary

Test Yourself

References

Risk, Value, and Financial Prices

Overview

Value and Price

Utility, Risk and Money

Lotteries and Utility Functions

Example: The utility of a lottery

Example: The power utility function

Example: Valuation and the Pricing of Cash Flows

Example: Risk and the Financial Meltdown

Utility Rational Foundations

Examples: Specific Utility Functions

The Price and the Utility of Consumption

Example: Kernel Pricing and the exponential utility function

Example: The Pricing Kernel and the CAPM

Example: Kernel Pricing and the HARA utility function

Summary

Test Yourself

References

Applied Utility Finance

Overview

Risk and the Utility of Time

Assets Allocation and Investments

Example: A Two securities problem

Example: A 2 stocks portfolio

The Efficiency Frontier

A Two Securities Portfolio

Conditional Kernel Pricing and the Price of Infrastructure Investments

Conditional Kernel Pricing and the Pricing of Inventories

Agency and Utility

Example: A linear risk sharing rule

Information Asymmetry: Moral Hazard and Adverse Selection

Adverse Selection

The Moral Hazard Problem

Signaling and Screening

Summary

Test Yourself

References

Derivative Finance and Complete Markets

Discrete States

Overview

The Arrow-Debreu Fundamental Approach to Asset Pricing

Example: Generalization to n states

Example: Binomial Option Pricing

The Implied Risk Neutral Probability

Example: The Price of a Call option

Example: A generalization to multiple periods

Options and their Prices

Put Call Parity

Proving the Put-Call Parity

Example: Put Call Parity and Dividend Payments

Options PUT-CALL Parity

The Price deflator and the Pricing Martingale

Pricing and Complete Markets

Options Galore

Example: Look-Back Options

Example: Asiatic Options

Example: Exchange options

Example: Chooser Options

Example: Barrier and Other Options

Example: Passport Options

Options and Their "Real Uses"

Example: Pricing a Forward

Example: Pricing a floating rate bond

Example: Pricing fixed rate bond

Example: The Term Structure of Interest Rate

Annuities and Obligations

Pricing and Franchises with a Binomial Process

Pricing a Pricing Policy

Options Trading, Speculation, and Risk Management

Example: Options and Trading Practice

Example: Insuring and derivative hedges

Portfolio Strategies

Summary

Martingales

Example: Change of Measure in a Binomial Model

Example: A Two Stages Random Walk and the Radon Nikodym Derivative

Formal Notations, Key terms and Definitions

Test Yourself

References

Options Applied

Overview

Introduction

Optional Applications

Pricing a Multi Period Forward

Example: Options Implied insurance pricing

Random volatility and options pricing

Real Assets and Real Options

The Black Scholes Vanilla Option and the Greeks

The Greeks and Their Applications

Summary

Test Yourself

References

Credit Scoring and the Price of Credit Risk

Overview

Credit and Money

Credit and Credit Risk

Pricing Credit Risk: Principles

Credit Scoring and Granting

Credit Scoring: Real- Approaches

Example: A Separatrix

Example: The Separatrix and Bayesian Probabilities

Probability Default Models

Example: A Bivariate Dependent Default Distribution

Example: A Portfolio of default loans

Example: A Portfolio of dependent default loans

The joint Bernoulli default distribution

Credit Granting

Example: Credit Granting and Creditor's Risks

Example: A Bayesian default model

Example: A Financial Approach

Example: An Approximate Solution

The rate of return of loans

The Reduced Form (Financial) Model

Example: Calculating the spread of a default bond

Example: The Loan Model Again

Example: Pricing default bonds

Example: Pricing default bonds and the hazard rate

Examples

Example: The bank interest rate on a house loan

Example: Buy insurance to protect the portfolio from loan defaults

Example: Use the portfolio as an underlying and buy or sell derivatives on this underlying